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Accounting theories and practices

Accounting theories and practices

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Published by daniel Sbstn

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Published by: daniel Sbstn on Aug 23, 2009
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Introduction to Accounting Theory
Theory
A statement on belief expressed in a language.
A deductive system in which observable consequences logically follow from the conjunction of observed facts with the set of the fundamental hypotheses … (Braithwaite, 1968)
A coherent set of hypothetical, conceptual and pragmatic principles forming the general framework of reference for a field of inquiry.
A set of premises which is logically related.
Accounting
The process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information.
Accounting Theory
A set of interrelated concepts, definition and propositions that present a systematic view of  phenomena by specifying relations among variables with the purpose of explaining and predictingthe phenomena.
Logical reasoning in the form of a set of broad principles that provide a general framework of reference by which accounting practice can be evaluated and guide the development of new practicesand procedures.
Nature of accounting theory
a.Accounting as a language
Perceived as a language of business.
Business activities are reported in accounting statements using accounting language.
Translate economic event and transactions into smthg that can be understood by users. b.Accounting as a historical record
Concern with providing a faithful record of the transactions of an entity and manager stewardship of the owner’s resources.c.Accounting as an economic good
Accounting info is not costless to produce and impose compliance costs.
Manager chooses accounting rules that minimize info costs and shareholders imposeaccounting rules that improve the ability to control and monitor the actions of managers.d.Accounting as current economic reality
Balance sheet and income statement should be based on a valuation basis that is morereflective of economic reality rather than historical costs. Focus on current and future prices.e.Accounting as communication-decision information
Accounting is action oriented. Accounting is prepared to suit the needs of users and willhave impact on the decision-making behaviour of managers and investors.
Accounting Theory Construction and Formulation
Accounting theory can be constructed by using deductive and inductive method.
Acceptance of a theory depends on the ability of a theory to explain and predict thevalidity / logical process of the theory’s construction, and the implication of the theory.1.Deductive method
Begins with basic accounting premises and proceeds to derive by logical meansaccounting principles that serve as guides and bases for the development of accountingtechniques.
From general to specific. Eg.
 
 
Deductive method:P1 All assets accounts have debit balancesP2 Building & machine accounts are asset accountsC Building & machine accounts have debit balances
Steps: a. specifying the objectives of financial statements.b. selecting the postulates of accounting.c. deriving the principles of accounting.d. developing the techniques of accounting.
Advantages- if premises are false, conclusion may also be false. Provide a basis for  practical rules.
Criticism- misunderstands the meaning of theory. The theory not necessarily to be entirely practical.2.Inductive method
Begins with observations and measurements and moves toward generalized conclusions.
From specific to general. Eg.Inductive method:P1 Building account is an asset account and has a debit balanceP2 Machine account is an asset account and has a debit balanceP3 Land account is an asset account and has a debit balanceP4 Vehicle account is an asset account and has a debit balanceC All asset accounts have debit balance
Steps: a. recording all observations.b. analysis and classifying of these observations to detect recurring relationships(similarities)c. inductive derivation f generalizations and principles of accounting fromobservations that depict recurring relationships.d. testing the generalizations.
The truth of the propositions depends on the observation of sufficient instances of recurring relationships.
Advantages: not necessarily constrained by a structure and free to make relevantobservation.
Disadvantages: influenced by the idea of relevant relationship and raw data are likely to bdifferent.
3 types of relationships in the theoretical structure:-
1.Syntactic relationship
 
Logical relationship which has to do with the rules of the language used.
Relates basic concepts at the abstract level.
Emphasis on the logical reasoning and not the empirical content of the statement in thereal world.
Refer to a flow of logic, not to the accuracy of an argument’s representation of the realworld.
If the premise is true, the conclusion must be true. Eg.P1 All accounts related to assets have debit balancesP2 Acc. Depreciation account is related to assetC Acc. Depreciation account has a debit balanceSyntactically, the argument is validIf P1 and P2 are true, then C also true: although the real world / practice, C is false2.Semantic relationship
Relates basic concepts of a theory with the real world.
Verification is based on the premises and conclusion, not on the logical reasoning.
Make a theory realistic and meaningful. Eg.P1 All assets accounts have debit balancesP2 Sales return account is not an asset accountC Sales return account has a debit balanceP1 is false. Syntactically, the argument is not validHowever, semantically, C can be accepted because in the real world/ practice, C is true.3.Pragmatic relationship
Effects of words or symbols to people.
How accounting concepts and real world corresponding events or objects affect people behaviour and how people react to the same message in different ways.
Testing a Theory
1.Dogmatic basis
We believe in statements made by others simply because they have been made by anauthority.
It is a basis for accountant to accept the validity of rules and procedures.
Weakness- introspective evidence including personal bias. Individual’s personal opinionabout the person or group making the statement.2.Self-evidence basis
Determination of truth- reasonableness, sensibility or obviousness of a statement based ongeneral knowledge, experience and observation.
Does not matter where the idea come from when constructing a theory.

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